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The interest rate rise will directly affect victims of austerity – the government should take responsibility

The hike will raise the cost of servicing existing debt without having an impact on inflation, putting severe pressure on already strained consumer incomes

Grace Blakeley
Sunday 05 August 2018 15:15 BST
Bank of England announces rise in interest rates

This week, the Bank of England (BoE) decided to increase the rate at which it lends to commercial banks from 0.5 per cent to 0.75 per cent. This is the highest the so-called base rate has been in almost a decade, though it remains well below the 5 per cent seen in 2007.

Changing the base rate is one of the tools the BoE has at its disposal to control inflation. Raising the base rate increases the cost at which private banks borrow from the BoE – an increase they are meant to pass on to consumers and businesses. Higher borrowing costs rein in business spending on wages and investment, and consumer spending on goods and services, thereby reducing inflation.

But it is hard to see the justification for such a move today. Business investment in the UK is lower than most other advanced economies and we are undergoing the longest period of wage stagnation since the Victorian era. It is true that consumers are spending more than they are earning: consumer debt is almost as high as it was before the financial crisis, and 2017 was the first year since 1988 that households’ spending exceeded their incomes. But people are beginning to realise that the fall in their wages may not be a temporary blip. After dropping to record lows, household savings rates have risen rapidly over the last quarter as people prepare for several more years of economic pain.

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Instead, the relatively high inflation rate of 2.3 per cent is being driven by the fall in the value of our currency, which has made imports more expensive. The UK’s current account deficit reached a peacetime record of 6 per cent of GDP in 2016 because we are buying so much more from the rest of the world than we are selling. As our decimated import-dependent exporters can’t simply step up production to take advantage of the weaker currency, increased import prices have been directly passed onto consumers.

In this context, an interest rate increase will increase the cost of servicing existing debt without impacting inflation. This will have a severe impact on already strained consumer incomes, particularly for those at the bottom of the income spectrum. There are almost 8 million households in the UK that have debts worth at least a third of their annual incomes. Some consumers are already being charged 10, 50 or even 100 times the base rate of interest by non-competitive banks or unscrupulous payday lenders.

In fact, 10 million households are spending more than a quarter of their incomes on debt repayments. This week’s rate rise is likely to embolden lenders to extract yet more from borrowers, particularly the most vulnerable.

Members of the Monetary Policy Committee (MPC) know all this, so why have they chosen to increase interest rates?

What Mark Carney will not say is that raising interest rates may also have an impact on the value of our currency. While the impact of the announcement has been negative so far – because expectations about our future economic health matter more for the value of sterling than a 0.25 percentage point increase in interest rates – this may change with future rate rises. Money and financial assets flow into countries that offer a higher rate of return on investment, which is linked to the interest rate.

The MPC may have agreed that the only way to tackle inflation is to try to increase the value of sterling to reduce the costs of imports. But in doing so, it is likely to choke off demand for years to come. A higher currency will reduce the competitiveness of our exports.

Combined with high interest rates and lower levels of consumer demand, this is likely to constrain business investment. Given that investment should be one of the main engines of growth, rising interest rates may keep the UK economy trapped in its current malaise for years to come.

The sector that will benefit most from this change in monetary policy is finance. If the interest rate rise does lead to an increase in investment flows into the UK, this new capital is likely to flow into financial assets and real estate, benefiting financial institutions in the City of London.

The only way to sustainably increase growth and improve living standards is to boost the non-financial economy in the UK. That means keeping interest rates low and increasing public investment through a targeted industrial strategy designed to boost the UK’s manufacturers. It’s high time that this government stopped relying on the BoE to boost the economy and stepped up to the task itself.

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